Are Subprime ABS and Auto Finance Growing Shaky?

Subprime ABS sales have been strong, and in fact subprime auto loan securities reached a record high in June, but now some investors are beginning to feel a little nervous. Are subprime ABS sales and BHPH auto finance growing shaky, or are investors the only thing trembling? What could it mean for your BHPH dealership?

This past May encountered better recovery rates, which helped to improve overall ABS metrics in the U.S. However, some investors fear that may not be enough. S&P Global Ratings found that 2015 and 2016 cumulative net losses in the BHPH industry neared recession levels, and the 2017 numbers rose even higher. In fact, the numbers are starting to look like those recorded a decade ago in 2007 and 2008. Recently. S&P Global made released its first negative ratings within the realm of subprime ABS in seven years.

The reason? S&P Global analysts reported that a major reason may be the shift in subprime auto loan bonds being sold. Investors have been buying up larger numbers of deep subprime auto loans as they seek to find greater profits in greater risks. Add to this the fact that, according to 2017 benchmarks, more BHPH dealerships are attempting to compete by financing newer used cars to higher-risk customers without significantly increasing down payments or monthly payments, and it is easy to see how the current BHPH market could become unstable. However, there is a large difference between perceived risk and actual trouble. Are subprime ABS sales and BHPH auto finance really on uncertain footing?

Compeer Financial’s vice president of asset management, Bill Moore, thinks it may be. Calling current auto finance numbers a “canary in the coal mine,” he warned that there are signs that, like the housing and dot com bubble bursts, the U.S. economy could be heading for another recession, this time driven by subprime auto financing. Moore stated that there are warning signs beginning to appear in subprime auto financing.

“You’ve got specialized lenders who are focusing on auto finance, particularly on subprime, that are gathering together loans, structuring them into asset-backed securities and selling them for the market,” Moore explained in an Agrinews interview. “Consumption, since 2016, on the consumer side, has outpaced income growth for two consecutive years,” he continued. “25 percent of the auto loans written today are subprime. We were doing that on the subprime housing loans in the early 2000s. It certainly didn’t work out great.”

Not everyone agrees, however. Despite the numbers it reported, S&P Global is not willing to predict a subprime auto driven U.S. recession just yet. Analysts were quick to point out that some parts of the subprime ABS market are actually performing better than a year ago. Losses decreased from 0.60 percent in April 2017 to 0.47 percent in May 2018, and recoveries increased to 70.44 percent in April 2018 from 65.25 percent in April 2017. So, according to S&P Global, the subprime ABS and financing situation is not yet dire.

What does all of this mean for you and your BHPH dealership? According to Kenneth Shilson of NABD/NIADA, the secret to keeping the market stable is to focus on keeping customers sold more than simply making sales. After the 2017 BHPH benchmarks were released, he analyzed thousands of BHPH deals, and found that dealers who accurately assessed how much car a customer could realistically afford, and financed accordingly, usually came out on top. Offering newer used cars with lower down payments and longer financing terms might draw in more initial sales, but it will be difficult to keep those customers sold for long. While the subprime ABS and auto finance market may be getting a little shaky, dealerships have the power to help stabilize it through prudent loan and business practices.

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